International Financial Management: inbu 4200 Fall Semester 2004 Lecture 4: Part 2

International Financial Management: INBU 4200 Fall Semester 2004

• Lecture 4: Part 2

• International Parity Relationships: The Purchasing Power Parity; A Case Study of the Impact of

• Hyper-inflation on a Currency’s Exchange Rate

• (Chapter 5)

Background on the Turkey and the Lira

• During the decade of the 1990s, Turkey experienced hyper inflation. The CPI peaked at 106.3% in 1994.

• One of the consequences of this hyper inflation was a severe depreciation of the country’s currency, the Turkish Lira.

• From an average of 9 Lira per US Dollar in the late 1960s, the currency came to trade at approximately 1,650,000 per US Dollar in late 2002 and early 2003.

• Now trading around 1,500,000

Turkey’s Rates of Inflation: CPI

• 1991 66.0% 1998 84.6%

• 1992 70.1% 1999 64.9%

• 1993 66.1% 2000 54.9%

• 1994 106.3% 2001 55.4%

• 1995 88.1% 2002 45.0%

• 1996 80.3%

• 1997 85.7%

Lira: 1991 - 2004

Lira Today

• Lira is the world’s smallest valued unit of currency.

• One lira worth approximately 0.000000743971 US dollars!

• A chocolate bar can often cost more than a million Lira!

20,000,000 Lira banknote

Changing Currency

• The Government has announced the introduction of a new currency to replace the old Lira.

• The new currency, the New Turkish Lira will be issued on January 1, 2005.

• It will be equivalent to 1,000,000 old Turkish Lira, or
• One New Lira will be worth one million old ones

General Conclusion

• Relatively high rates of inflation result in weakness (depreciation) of a country’s currency on foreign exchange markets.

• Theoretical explanation for this relationship, is the Purchasing Power Parity model.

• Exchange rates will change by an amount which is equal to, but opposite in sign to, inflation differentials.
• High inflation country currencies will weaken
• Low inflation country currencies will strengthen

Kataloq: palmerm
palmerm -> It is assumed that relatively high rates of inflation will result in weakness (depreciation) of a country’s currency on foreign exchange markets